An indenture is the contract between the issuer and the bondholder specifying the issuer's legal requirements. It contains the promises of the issuer and the rights of the holder of the bond.
Bondholders may have great difficulty in ascertaining whether the issuer has been fulfilling its obligations specified in the indenture. The indenture is thus made out to a third-party trustee as a representative of the interests of the bondholders; a trustee acts in a fiduciary capacity for bondholders.
Legal Identity of the Bond Issuer and its Legal Form
The issuer is identified in the indenture by its legal name. It is obligated to make timely payments of interest and repayment of principal. Bonds can be issued by a subsidiary of a parent legal entity. They can also be issued by a holding company. A special-purpose vehicle/entity (a separate legal entity) can issue bonds collateralized by assets transferred from its sponsor. If bankruptcy occurs, the sponsor's creditors cannot go after such assets; this is known as bankruptcy remote.
Source of Repayment Proceeds
The source of repayment proceeds varies, depending on the type of bond.
Asset or Collateral Backing
Collateral backing can increase a bond issuer's credit quality.
An unsecured bond is not secured by collateral.
Covered bonds are debts issued by banks that are fully collateralized by residential or commercial mortgage loans or by loans to public sector institutions.
Credit enhancement reduces credit risks. Internal credit enhancement considerations include:
External credit enhancements are financial guarantees from third parties. Examples include surety bonds, bank guarantees, and letters of credit. If the third-party defaults, the external credit enhancement will fail. A cash collateral account can mitigate this concern.
Affirmative covenants set forth certain actions that borrowers must take, such as:
Negative covenants set forth certain limitations and restrictions on the borrower's activities, such as:
| sarath: Negative - restrictions on borrowers activities...|
affirmative - actions borrowers must take....
| manyu: brief and to the point |
|jaimaa: good stuff|
|malikmax: really good stuff.|
|emmaskool: This is the best study site I have ever seen.|
|DariSH: Any financial covs?|
|yesandy11: Affirmative Action is quite easy to remember for some reason...|
|mhanazi123: It is helpful and easy for memorization|
|khalifa92: @emmaskool: this site is very simple and user-friendly but in case of informativity the CFA books are still first.|